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Main residence Nil Rate Band – don’t turn your back on IHT planning

The 8 July 2015 Summer Budget confirmed that a new ‘Main Residence Nil Rate Band’ will be available in addition to the existing NRB of £325,000 (2015/16).

This main residence NRB will be phased in from 2017 and will eventually reach £175,000 per person in the 2020/21 tax year. The additional allowance will only be available where a family home or ‘main residence’ is transferred to a direct descendant of the deceased. This could result in an overall NRB of £1 million for married couples or civil partners and is believed to keep the majority of UK homes free to be passed down the generations without a liability to IHT.

IHT planning often involves outright gifting, placing money into trust arrangements as well as Life assurance policies to cover the predicted tax bill, but are these still valuable now that the Chancellor has given this extra allowance?

So how will the new allowance work?

The main residence nil rate band will be the lower of the net value of the interest in the residential property (i.e. after deduction of outstanding mortgage) or the maximum amount of the band. So a property of £250,000 with a mortgage of £100,000 in 2020 will have a limit of £150,000 main residence NRB rather than the full band amount of £175,000.

The residential interest will be limited to one property but personal representatives will be able to nominate which property should qualify if there is more than one. A property which was never a residence of the deceased, such as a buy-to-let will not qualify.

The additional allowance will be available from 6 April 2017 at the following rates:

Year                    Additional Main Residence NRB
2017-18 £100,000
2018-19 £125,000
2019-20 £150,000
2020-21

£175,000

 

 

 

 

 

 

This will increase in line with CPI from 2021-22 tax year onwards

Spouses including civil partners will continue to inherit their deceased partners standard NRB and from 2017 will be able to inherit the new main residence allowance in addition, even if there deceased spouse died before 2017. This could result in a total of £500,000 (£175,000 + £325,000) from 6 April 2020 being available to inherit on second death.

For some the main residence NRB will help avoid IHT on their estate at least in the short term. If the only family asset is the house with some savings this new measure will help to pass a family home to descendants without incurring an IHT bill. To demonstrate I have provided an example:

Mr & Mrs Smith’s assets:

Family home – valued at £750,000

Savings amounting to £125,000

Position before introduction of ‘Main Residence NRB’

On first death, assuming both the house and the savings are passed between spouses then the transfer is exempt from IHT and £325,000 NRB can be inherited. On second death however the estate is valued at £875,000 therefore even with the inherited NRB, £225,000 is liable to IHT at a rate of 40%. This would have to be paid prior to the descendants inheriting the house and savings (some access to savings accounts may be available).

Position after

On first death nothing changes assuming the spouse inherits the estate. However, on second death (in 2020-21) the position is quite different. A combined Main Residence NRB of £350,000 is available for the main residence leaving £400,000 excess along with the £125,000 savings to be tested against the standard NRB of £650,000 (£325,000 for both husband and wife).

As there is sufficient NRB available no IHT is due on the estate and the descendants are not required to pay IHT before inheriting the assets.

For larger estates (£2 million net value after liabilities/debts) the main residence NRB will taper away at a rate of £1 for every £2 over this threshold. So for an individual with an estate of £2.35 million no main residence allowance would be available. The taper threshold will also rise with CPI from the tax year 2021-22 onwards.

The new legislation will also provide measures to protect someone who has chosen to sell their main residence to downsize to a less valuable residence or had ceased to own a residence on or after 8 July 2015. Details of how this will work will be the subject of a consultation to be published in September 2015.

Is IHT planning less important?

The rise in the IHT NRB on residential homes is a welcome move however if the NRB hadn’t been frozen back in 2009, the ‘real’ increase would be much less than the budgets headline figure. Since April 2009 average house prices have risen by 36.6% (based on the mix adjusted rate)* making the current IHT threshold vastly out of date with current property prices and leading to more families being caught by IHT. If the NRB had kept pace with house price inflation, the £650,000 joint IHT allowance would stand at £887,900 today, just £112,100 less than the £1m headline figure.

With the NRB now being frozen until the end of 2021 the £1m figure could have been achieved by a steady increase in the standard NRB from 2009 and would have provided more flexibility for those with a more modest house but similar total estate value. With all of this in mind IHT planning is still important for many families.

Who still needs to plan for IHT then?

This list is not exhaustive however, below are some examples of where IHT planning solutions are still crucial to help reduce or eradicate a tax bill.

  • Clients who want to take control of their tax liabilities and not wait till death to mitigate tax, especially in a political and economic climate where each year we see the government upping the tax take
  • Clients with a heavily investment-weighted estate (buy-to-let portfolio, investment bonds etc.) – it is likely that the main residence NRB will assist in reducing the bill but the investments themselves will not benefit from it
  • Clients with a property close to the (enhanced) NRB - it is likely that house prices will increase at a rate higher than the allowance (CPI) meaning that there will be an excess on death
  • Clients who have made sizeable gifts but are worried about dying within 7 years of the gift -any failed gifts will reduce the standard NRB leaving the estate more vulnerable to IHT
  • Clients who are not married and/or with no direct descendants or those who would like to leave their main residence to a brother or sister - main residence allowance only available to direct descendants
  • The above demonstrates that the new main residence NRB is a welcome relief for some families however, for those with an estate made up of more than just the family home the role of an adviser in providing IHT solutions is still an important one.

* Data source: ONS - House Price Index (HPI) – published 19 May 2015. Databased on the mix adjusted average house prices. Mix adjusted house price in 2009 was £194,000, in 2014 was £265,000

 

 

The information provided in this article is not intended to offer advice.

It is based on Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual International cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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